Tuesday, January 15, 2008

Gold's Come-Back as a Monetary Metal

So, even the editors of the prestigious Financial Times are beginning to talk about gold's staying power. In an editorial from January 7 entitled "Gold is the new global currency", we can decipher (between the lines) my oft-repeated mantra:

You can take gold out of the standard, but you can't take the standard out of gold.

Here's what they actually say:

"Part of gold’s allure is its traditional status as a safe haven. It is seen as a store of value when everything else seems risky. But the bigger drivers behind the rising spot price are a depreciating dollar and the prospect of negative US real interest rates."

Right on. Some people are no fools, in spite of what the central bankers may believe. Wiser members of the public, including some large investors, believe:

(1) That excess money creation through credit pushing by the Federal Reserve and other central banks around the world has created bubbles in the economy;

(2) That those bubbles now so evident in the US, i.e. in real estate, mortgage lending, and "Wall Street" speculation, are no exceptions and are signals of particularly pushy recent credit maneuvers by the US central bank; and

(3) That the academics can throw around phrases like "global savings glut" and "increased emerging-economy demand" until the proverbial bovines return to the barn, yet gold will always be the ultimate store of value in times of monetary excess, which we believe is now for the fourth time in US central bank history: Leading up to crises in 1929, the 1980s, 2001, and today. (Note how the market is taking less and less time to wise up each time.)

Yes, saving is a popular pastime in Asia, and yes demand for oil, etc. from those countries is increasing; but why are these savings and that demand only appearing after 2001? And how did those enormous state funds get so big, holding onto all that wealth, if the savings were already invested in the US? If you think the savings glut is the cause of our bubbles, just you wait until they really start investing the rest of their savings here as our asset prices bottom out. The rush has just begun.

And yes it's true, gold's value fluctuates wildly; but this wouldn't happen if governments didn't play with the monetary unit. When governments do, you can bet they will screw things up and that gold will, as usual, be the ultimate bubble, whether it's now or within the next decade or so.

In fact, gold's instability is a kind of thermostat, telling us how good our central bankers are doing. This is its new-found role in our global monetary system: Central Bank Watchdog. It's the opposite of the canary in the mine shaft: Gold thrives when the fragility of our monetary system reveals itself and grim reality sets in.

[Thanks to conspec-controls.com for the photo.]

For the uninitiated, the control of the issuance of money has always been a power and source of wealth that governments have craved. They have given themselves this monopolistic power and wealth in past centuries on many occasions.

Indeed, over the past 100 years, the world has given the US much of that monopolistic power and wealth by turning the US dollar into a global reserve currency and imposing its use in ground-level transactions in world markets for the pricing of fundamental products like oil, diamonds, and gold itself.

But the world may be changing it's mind. The dollar is no longer "as good as gold." This is normal. Governments have only managed to preserve their nation's unit's purchasing power over time when they have disciplined themselves by tying its exchange value to something like gold or silver, things that have "intrinsic" value, i.e. something people would care to hold or obtain under almost any but the most desperate circumstances.

Today, as has happened in the past, there is no such fixed exchange standard. Instead, the markets now determine the exchange value of our money, and the governments control the quantity of it by what is called "fiat," issuing it as they see fit.

This is dangerous in the long run.

Reason No. 1: Money is not a commodity. It is not something that has a "market value," like oil, Chinese dolls, or chocolate. It is a contract between two parties, something my Dad, a little-known economist named E.C. Harwood, used to call "a promise to pay," or a "warehouse receipt" of sorts. As such, it is not subject to market evaluation, except under deceptive circumstances.

Reason No. 2: Governments have always failed to maintain their monetary unit's purchasing power over time under such a fiat unstandardized regime.

What is worse, the decline in purchasing power doesn't always happen smoothly, or imperceptibly. At times, the decline is abrupt and disruptive. The recent decline in the exchange value of the dollar is an example of such a disruptive decline, losing as some claim up to 73 percent of its exchange value over the past 39 years. (I recommend consulting Michael Hodges's Grandfather Economic Report for a clear explanation of our present US financial woes and how we got here.)

Another well-regarded newspaper, the Wall Street Journal, published yesterday an opinion piece by David Malpass, chief economist at Bear Stearns, of all places--I say that because we all assume that most of the finance houses would be advocating a loosening of monetary policy, whereas Mr. Malpass says, "the clear alternative [to more rate cuts] is to strengthen the dollar first" presumably by tightening monetary policy, although he doesn't give any blueprint.

This is a most interesting fulcrum moment in US monetary history. Bernanke's Fed will find it nearly impossible to strengthen the dollar through tightening, especially in the upcoming news environment that is already beginning to harp upon recession fears.

Which is good for gold, in the middle run. Short and long are another matter, because they depend on what the US Fed will do from here on in.

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